Most people will at some point in their lives become involved in some manner with the insolvency of a company.

They may deal with or work for a company that is unable to pay its debts, or they may be a customer of a company that becomes insolvent and ceases to trade.

Insolvency may result from a variety of causes.

Examples include a change in market conditions, bad management - including poor financial controls, fraud or other breach of contract, or where a tort is committed against the company causing severe uninsured financial loss.

The directors, who are responsible for the management of a company, are primarily responsible for ensuring that a company remains solvent while it continues to trade.

Bermuda law, when complied with, ensures that directors monitor the financial position of the company.

Should a company be unable to pay its debts as they fall due, or if its liabilities exceed its assets on the balance sheet test, prudent directors should ensure that the company ceases to conduct business.

If the directors fail to take such action promptly and instead continue recklessly or fraudulently they may be held personally liable for the debts of the company.

Under Bermuda law there are two principal solutions for a trading company when faced with insolvency.

The first is to commence with a creditors voluntary winding up and the second is to file a winding up petition.

Both of these procedures lead to the appointment of a liquidator and the cessation of the powers of the board of directors.

A liquidator is an individual who is obliged by law to ascertain the assets and liabilities of a company. A liquidator can be empowered by the Court to continue the business of the company in certain circumstances.

Generally the liquidator is required to administer the assets of the company and distribute them to all creditors on a pro rata basis.

Certain creditors enjoy preferential rights over other, unsecured creditors.

Firstly, creditors who hold security for their debt do not rank within the class of creditors entitled to share in assets of a company in liquidation unless they are prepared to release their security.

Security in this sense means a right such as a mortgage over an asset formerly in the ownership of the company.

A class of creditors - for example, Government in respect of various and specific taxes owed, or employees up to a specified dollar amount - are known as preferential creditors, and rank ahead of general unsecured creditors.

Unsecured creditors would include any creditor dealing with the company on a day to day basis that do not fall within one of the first two categories.

It is possible for creditors to contractually create an additional class of indebtedness known as subordinated indebtedness. This class would rank behind the claims of unsecured creditors.

The manner in which the liquidator carries out his or her powers and duties will depend in large part upon the nature of the business conducted by the company.

This can take from a matter of months for a simple trading company to several years for a company engaged in complex activities such as insurance or reinsurance.

This can be frustrating for creditors, who can do little to enhance their position once they have given the liquidator notice of a claim against the insolvent company.

In certain situations, there are various principles that may assist a general unsecured creditor to realise a greater part of their claim than other unsecured creditors.

For example, a supplier of goods to the company may benefit if a valid retention of title clause was incorporated into their contract with the company.

A creditor who is also a debtor of the company may be able to exercise rights of set-off against the insolvent company.

General unsecured creditors may find that they possess some kind of proprietary right to the assets of the company and may be able to argue that the assets held in the name of the company are in fact the property of the creditors.

However, the reality is that in many cases at the conclusion of an insolvent winding up, the amount that is available for distribution to general unsecured creditors is very small.

This can be because of the extent of insolvency, or because the level of preferential debts was so high as to make a payment to general unsecured creditors impossible.

The difficulties faced by creditors who try to recover funds from insolvent companies highlights the need for creditors to ensure proper credit control to their customers.

It also points to the desirability of inserting a retention of title clause, or other mechanisms, into their contracts that would allow them to recover assets from insolvent companies. Attorney Jennifer Y. Fraser is a member of the Insolvency Team of Appleby Spurling & Kempe. Copies of Mrs. Fraser's columns can be obtained on the Appleby Spurling & Kempe web site at www.ask.bm.

This column should not be used as a substitute for professional legal advice. Before proceeding with any matters discussed here, persons are advised to consult with a lawyer.